The uncertainty
One of the main priorities of Portugal’s recently inaugurated XXV Government is to address the ongoing housing crisis, which has been manifested in two ways: a reduction of housing supply and, as a direct consequence, a sharp increase in property prices, especially in major urban centres.
To tackle this issue and encourage the supply of private, public, and cooperative housing, a government programme approved on June 18 introduces a set of emergency measures for the housing sector. Among these is the creation of an exceptional and temporary regime designed to eliminate or reduce tax costs associated with construction or rehabilitation works on properties intended for permanent housing. Importantly, this regime applies regardless of whether the property is located within designated urban rehabilitation areas, thereby broadening its potential impact nationwide.
This special regime provides for compensating municipalities for lost revenue resulting from several intended measures; namely:
A substantial reduction or elimination of urbanisation, building, use, and occupation fees;
The application of a reduced VAT rate to construction and rehabilitation works and services, with a cap on the final value of eligible properties; and
The “extension of deductibility” of VAT.
While the reduction of the VAT rate on construction services from 23% to 6% (in mainland Portugal) for new construction and rehabilitation of properties – regardless of the property’s location – was largely anticipated by stakeholders, there remain uncertainties about the practical application of this reduced rate, particularly due to the cap on the final value of eligible properties.
However, the government’s reference to the “extension of deductibility” of VAT is particularly noteworthy and somewhat unexpected. The government’s mention of “extension of deductibility” in the context of VAT on construction and rehabilitation services suggests a potential shift in the VAT treatment of real estate operations in the residential sector. Currently, a deduction of input VAT by businesses is only permitted when their subsequent transactions are subject to VAT. In Portugal, both the sale and lease of residential property are exempt from VAT, which means businesses cannot recover the VAT paid on construction or rehabilitation expenses for residential properties. There is also no mechanism allowing operators to opt out of this exemption in the residential sector, further preventing VAT deduction in these cases.
If the government’s intention is indeed to extend the deductibility of VAT on construction and rehabilitation costs for residential properties, this would require a structural change in real estate taxation. Specifically, the first sale of new housing would be subject to VAT, as permitted by Council Directive 2006/112/EC (the VAT Directive), and stepping out of the derogation provided for in Article 377 of the VAT Directive, which establishes that Portugal may exempt from VAT real estate transactions. Ideally, this would be accompanied by the elimination of property transfer tax (imposto municipal sobre transmissôes onerosas de imóveis, or IMT) on the sale of new homes, which aligns with the government’s plan to compensate municipalities for lost revenue.
Although uncertainties remain regarding the precise scope of the government’s objective to extend deductibility, it is important to highlight that replacing IMT with VAT (preferably at a reduced rate) on the sale of new residential properties would be ambitious and innovative in Portugal. The measure would eliminate the cost that construction VAT currently (and other input VAT) represents for real estate development, particularly in the residential sector, and could significantly reduce housing costs.
Even though these measures – reducing VAT on construction services and extending VAT deductibility – may seem contradictory, they can, in fact, be complementary and form part of a coordinated strategy (for example, one could result from new property sales being subject to VAT, while the other could positively impact sales of used buildings, which are typically VAT-exempt under the VAT Directive).
The certainty
Despite the uncertainties surrounding the scope of the “extension of deductibility” of VAT in the context of construction and rehabilitation, and recognising that such a significant change in real estate taxation may face implementation challenges, one thing is clear: an extension of VAT deductibility in the real estate sector can be achieved by revising the regime for waiving the VAT exemption on real estate transactions.
The current regime is complex and outdated (and, in certain aspects, in opposition to the principle of neutrality of VAT), which justifies an urgent review, although the housing segment should likely remain excluded from this review.
This intention was already reflected in the Agenda for Tax Simplification approved by the previous government, and it is expected that the current government will maintain the goal of revising the regime on certificates of waiver of VAT exemption, ideally going beyond mere formal changes.
Several aspects of the current regime require improvement, not only in terms of formalities but also in material aspects that hinder VAT deduction in the context of economic activities carried out in buildings. These include the subletting regime, the rules applicable to properties that have undergone major transformation and renovation, and the regime for mixed taxable persons.
In summary, there is significant anticipation regarding the government’s intentions in this area. At a minimum, revising the VAT exemption waiver regime in real estate transactions should be considered a baseline for extending VAT deductibility within the scope of real estate economic activity.
